UPA2: Dressing up to go nowhere

The UPA2 government has been generous to a fault. Economic reforms pursued since the 90s began to yield dividends in faster economic growth. Moderate taxes lent buoyancy to tax revenues that inched up to almost 17% of GDP. For a change the Government had money to spend. Unfortunately, instead of thinking afresh on how to spur growth in a manner that drew the rural poor into the development process, government chose to go back to discredited subsidies as means of poverty alleviation. And so it was back to open ended subsidies with a vengeance. Petro-products, fertilizers, food, and programs such as MREGA, blossomed into insatiable cash hungry machines. All told, subsidies now pull in something like $40 billion from a $1.4 trillion GDP or 3% of GDP. With government revenues of $252 billion, subsidies now absorb roughly 16% of all government revenue. These subsidies yield little by way of return either to government, or to the economy, and are clearly unsustainable.

Adverse economic developments in world economy, combined with near total policy paralysis together ballooning subsidies, has led to a slow down in the economy with growth rate dropping from 10% to about 6%. Relatively, revenues have shrunk while expenses have continued to rise. And subsidies continue to grow with increased coverage and expansion of the base. As a result, the fiscal deficit has shot up from something like 4.5% of GDP to something over 6.5%. Such a high level of fiscal deficit, along with a fragile balance of payment position, has sent alarm bells ringing from Delhi to Washington. Government has therefore pulled out all stops to somehow contain the fiscal deficit to a figure closer 5%. What else can a bankrupt government do but to sell the family silver? Hence the race to sell some equity in PSUs in order book some capital receipts that can cover the revenue shortfall and help pay out the subsidies.

Fire sale of PSU equity is being touted as privatization, or at the very least, disinvestment. However, the whole idea of privatization is to shed government control in management of state enterprises so that they can be run on normal commercial principles in order to generate profits and wealth for shareholders. The fact however is that, barring a few cases; government has never shed management control in disinvested enterprises. Instead it has used disinvestment as means of raising revenues to fund government expenditure and subsidies while making cosmetic changes in the way PSUs are managed. In cases like ONGC, and OMCs, government has in fact followed some of the worst corporate governances practices that have in effect robbed their private shareholders in order to meet government revenue and other political objectives. The attempted disinvestment of ONGC, its failure to attract bids in the auction, and the subsequent sequestering of LIC’s $2.25 billion to rescue the government from the ignominy of crass failure, amply illustrates the wrong corporate governance practices that government itself imposes on its enterprises.

ONGC is actually a crown jewel. It is India’s only oil exploration company with substantial proven reserves, extensive operating experience in onshore and offshore fields, and an a track record of efficient performance with operating profits. When the PSU was first offered for disinvestment in the market, the Government swore operational autonomy to its management and non-interference in its commercial operations. More to the point, the government promised to ensure that its gas & oil would be sold at market-determined prices to OMCs. Based on these solemn promises incorporated in an offer for sale document, ONGC shares were sold to a large number of foreign institutional investors. While ONGC enjoys a measure of operational autonomy, the government never shed control over company’s strategic management. In particular, as crude prices surged in international markets, the government foolishly failed to muster the political will to pass through the price increases to consumers. Instead it sought to subsidize them by passing on 1/3rd of the subsidy to ONGC, 1/3rd to OMCs while funding the rest through the general budget as an outright subsidy. This additional burden on ONGC was nothing but a disguised tax on its profits that were properly belonged to, and in fact were promised to, ONGC shareholders. The additional tax on ONGC amounted to $3billion per annum; a value that ONGC shareholders were unfairly deprived of. Had any private promoter pulled the same breach of promise on its shareholders it would have been dragged through courts for fraud. Quite naturally, foreign investors, fully aware how they were cheated out of value by the government, refused to buy the new shares offered by the government. Once bitten twice shy. Besides the boycott was intended as clear message from markets to the government.

The Government’s use of LIC to rescue it from the ONGC fiasco is even more shameful and illustrative of how the Government misuses its control over PSU managements to further its political objective of the moment in complete disregard of the PSU’s strategic objective and obligations to other stakeholders in the enterprise. LIC is not just a financial institution. Like banks, over and above its obligations to its shareholders, LIC has a legally well-defined obligation to its policyholders to manage their investments in the most prudent manner. To help Government salvage the ONGC auction, LIC permitted the government to commandeer $2.25 billion of its funds at just a few hours notice for buying ONGC share in the auction that others had pointedly refused to take up. Every prudential norm applicable to equity investments was thrown to the winds in the process. $2.25 billion is about 50% to 75% of the net funds that LIC earmarks for deployment in equity annually. LIC knew it was effectively underwriting the government and could have demanded a discount of at least 5% to the floor price to put in such a huge bid at the last moment. No such thought crossed LIC’s mind. It blindly obeyed government orders to deploy not its capital but policyholders’ capital. Could there be a more telling lapse of fiduciary responsibility? LIC incidentally has been working without an Executive Chairman [who is its CEO] for the last 9 months. What more can you say of the shoddy example government itself sets up for other promoters to follow? It is no wonder minority shareholders are regularly taken to the cleaners by most promoter groups in India.

Will the ONGC and LIC fiasco deter the government from proceeding further to window-dress the national accounts for what it assumes are gullible domestic and foreign investors? Unfortunately the Government has a far worse scheme up its sleeve to rob the poor minority shareholders for cash rich corporates like NTPC, NHPC, LIC and banks. These captive agents of the government, supposedly blessed with autonomous managements of the ONGC and LIC kind, are being offered shares in other PSUs of their kind! Is the government pretending that NTPC & others have not already earmarked their surplus funds for investment in their own businesses? Or is it that the PSU shares on offer represent a good investment opportunity? If so why not let in the public through an auction to discover a fair price? The simple fact is that government needs money to “reduce” its fiscal deficit and finds it convenient to commandeer the cash surpluses of these rich PSUs by offering them shares in other PSU that it cannot sell in the market because there is no buyer at the price it demands.

The methods being used to window dress the fiscal deficit will fool no one, least of all foreign investors or bodies like the IMF. Instead it will result in loss of confidence in the government’s sincerity, veracity and probity – a far greater loss than the mere embarrassment of issuing a mea culpa and promising to set things right. Let us pray that wiser counsel prevails and the government will not proceed with such obvious subterfuge merely to save its face in domestic politics where it still can fool most of the people some of the time.